G7 to discuss co-ordinated central bank action

BRUSSELS, Belgium — Financial officials from the Group of Seven industrialized nations will discuss how to co-ordinate action among their countries’ central banks, a person familiar with the matter said Saturday, following several days of market panic and a downgrade of the U.S. credit rating.

The person spoke on condition of anonymity because the level and timing of the contacts had yet to be confirmed.

Standard & Poor’s downgrade of the U.S. credit rating Friday night added to growing fears over debt levels and economic growth in the world’s biggest economy and in large European nations such as Italy and Spain. The downgrade is also set to hurt Europe, whose economy is closely linked to the U.S. and whose weak members depend on strong demand abroad for their goods to help them grow.

Many economists see the world’s big central banks as the last line of defence at this moment in the crisis, after policymakers in Europe and the U.S. have failed to agree on the kind of shock-and-awe moves that many investors demand.

In the eurozone, the summer recess of national parliaments is delaying the implementation of crucial changes to the currency union’s bailout fund that could help save Italy and Spain from expensive bailouts.

Possessing the power to create money, many central banks around the world have intervened in bond and currency markets in recent years in an effort to give their countries’ struggling economies a shot in the arm. Just this week, the central banks of Switzerland and Japan moved to push down the value of their national currencies, hoping to spur exports.

The U.S. Federal Reserve and the Bank of England, meanwhile, have injected huge amounts of money into their economies by buying up their own government bonds since the beginning of the crisis.

But so far, the European Central Bank has been reluctant to intervene in the Italian and Spanish debt markets as it has previously done for Greece, Ireland and Portugal, the three eurozone countries that have already been bailed out. Buying up government bonds can stabilize their prices during an investor sell-off and help carry a country through periods of market panic.

Luc Coene, the head of Belgium’s central bank and a member of the European Central Bank’s decision making board, said Friday that the ECB may be prepared to help Italy and Spain once the two countries have taken more concrete steps to get their public finances under control.

Many investors have also been calling on the U.S. Federal Reserve to start pumping money into the American economy again to help underpin the slowing economic recovery.

Both Italian Premier Silvio Berlusconi and EU Monetary Affairs Commissioner Olli Rehn on Friday called for co-ordination between G-7 countries, saying the crisis has to be tackled on a global level.

Berlusconi also announced that his country — burdened with a debt that stands around 120 per cent of economic output amid lacklustre growth — would speed up cuts to balance its budget by 2013 and take other steps to boost growth.

French Finance Minister Francois Baroin, whose country currently holds the G-7 presidency, said he had been in close contact with his G-7 counterparts “throughout the previous days and also this very morning.”

“We’ll be carefully watching the evolution of what might happen on Monday,” Baroin told France’s RTL radio, without providing details on the contacts. The G-7 members are Britain, Canada, France, Germany, Italy, Japan and the U.S.

The G-7 contacts come after one of the worst weeks in global financial markets since the collapse of U.S. investment bank Lehman Brothers in 2008.

Stabilizing Italy and Spain is set to be the biggest test for the 17-country eurozone, since their large economies are likely too big to support with full-blown bailouts.

Because of that, eurozone leaders last month decided to give their bailout fund new pre-emptive powers, such as the ability to buy distressed government bonds on the open market like the ECB, extend short-term credit lines or help re-capitalize struggling banks.

However, those new powers have not been implemented yet — a process that may take until early September unless national parliaments are called back from their summer recess. Analysts also warn that at the moment, the bailout fund is too small to successfully use its new tools.

Of the C440 billion ($623 billion) initially committed to the so-called European Financial Stability Facility, less than C300 billion ($425 billion) will be left once the two Greek rescue packages and the bailouts for Ireland and Portugal have been paid out.

Mansoor Mohi-uddin, a managing director at UBS, warned that besides undermining investor confidence in the U.S., S&P’s downgrade may herald similar action from rating agencies on other top-rated countries.

“The sovereign ratings of other AAA rated countries like the U.K. and France are likely to come under question,” Mohi-uddin said in a note.